Home loans: Should owners sell, pay down debt, or go delinquent?

Home owner Yvonne Macias, who received a home loan modification through Bank of America shows off paper work during The Neighborhood Assistance Corporation of America event in Phoenix Feb. 4, 2011. Three home owners pose questions about home loans in this edition of the reader mailbag.

Joshua Lott/Reuters/File

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What’s inside? Here are the questions answered in today’s reader mailbag, boiled down to five word summaries. Click on the number to jump straight down to the question.1. Handling a windfall2. Underwater on mortgage3. The best next step4. More for the mortgage?5. Saving up for payments6. Package price increase7. Maximize investments or pay mortgage?8. Exercising at home9. Buy cheap or reliable?10. Inherited jewelry

For those of you who have read The Simple Dollar for a while, I am a big fan of men’s college basketball, particularly the season-ending tournament to determine the champion. The excitement of the upsets of the early rounds gives way to the intense matchups of the late rounds. It’s a mix that I can barely resist.

Most years, I give some sort of prediction as to who I think the national champion will be. My pick this year? I predict Kansas wins. (Of course, the can’t-miss games for me are the BYU games because of the crazy three point shooting.)

Q1: Handling a windfallI am receiving in my divorce settlement $80,000 from my X2B’s 401(k). I know I can roll it directly into something else to avoid paying taxes on the gain right now, but what’s the best plan to roll it into? I have a small 401(k) at my job (only been here 2 yrs – I don’t know the amount off the top of my head but I think it’s with Vanguard) and a tiny (about $3-4K) 403(b) (or whatever the non-profit plan is) from a previous job (which I cannot add to unless I go back to work there). I need some guidance on (1) where to put the $80,000 I’m about to receive, and (2) how to do it. - Kym

You have several options, assuming that you have a Qualified Domestic Relations Order. If you don’t know what that is, give your divorce lawyer a call.

First, you can just leave it as a 401(k). It will stay at whatever company your husband’s 401(k) is at, but it will be considered your 401(k) and proceeds will grow for you.

Second, you can roll it over into a traditional IRA (no taxes now, but you’ll be taxed when you actually use it in the future).

Third, you can just pocket the money. Again, it’ll be treated as normal income and you’ll have to pay taxes on it, just like the traditional IRA.

I would probably choose the IRA option. It gives you the most control over the money and doesn’t result in a major tax concern. For help in making that happen, choose an investment house and directly request assistance from them. I use Vanguard for my current retirement savings.

Q2: Underwater on mortgageI live in Baltimore, MD and have the issue that unfortunately way too many other people in this country have in that my house is worth MUCH less than what the mortgage is for. I was able to buy the house on my own in June of 2006 and live in the heart of the city. At the time, buying a completely rehabbed place (downtown Baltimore and it’s surrounding neighborhoods are all rowhouses) for under $300K was a great deal and that’s exactly what I did. I was 24 and was given a mortgage without having to put much down at all. While I know now that this wasn’t the best move, at the time, I easily thought I would be able to sell the house in a few years for a profit or even rent it out for something at least close to the mortgage. Neither are true now.

The other night I was on Zillow and it had it worth $180K! While I still believe I would be able to get a bit more than this should I sell, it’s obviously no where near the $285K that I paid for it. Since I bought the house, I have gotten married and we both luckily have stable and good jobs. While nothing is 100% certain, we are both confident that our jobs won’t be going anywhere anytime soon. We do have some credit card debt as I just finished my MBA and had to pay via cards but those balances are being worked down fairly quickly. We have never missed a payment on any of our bills, including our mortgage and honestly we are financially OK paying these amounts while still contributing to our 401K, 403B, Roth IRA’s, savings, and regular trading accounts. I won’t go into our full financial situation since I don’t think it’s all that relevant to my question, but how does one go about talking to mortgage companies about a house that is probably worth $80-100K less than what the mortgage is for but at the same time, the owners are stable financially? Is there any sort of angle I can play with the mortgage company? I don’t want to start intentionally missing payments and messing my credit up when I’m able to pay the full amounts. Just because I’m lucky enough to pay the full amount, does that mean they won’t even talk to me about any possible options? I’m in a fixed rate (re-fied at 5% the end of 2009) loan with Wells Fargo but certainly wouldn’t complain if there was anything to be done about my monthly payment or the mortgage balance overall. I certainly don’t expect them to just “forget” about the difference in value, but I don’t want to threat not paying, foreclosing, or short selling when honestly I don’t need to. We are able to make the payments, but it kills me that we are paying so much more for something that is worth so much less now. I’m fine calling them but wouldn’t even know what to say or any sort of “buzz” words to actually have them work with me knowing that I’m financially OK. Any suggestions?! - Phil

The only angle you have on the mortgage company is the threat that they’ll have to take a devalued property. You owe them $250K or so and they’re not about to swap that for a $180K property without a very good reason (meaning the loss of the $180K property is lower than the risk of actually getting the $250K from you).

The sad part is that the current housing situation does nothing at all for the people who are far underwater on their homes but have been keeping up the payments. They usually can’t refinance, their lender doesn’t view them as a priority, and walking away destroys their credit for a long while.

What you need to decide is whether staying in that home (with the bad mortgage) is better than walking away and destroying your credit for a few years. I can’t really answer that question for you. It’s the same ethical dilemma that a lot of folks in your situation face.

Q3: The best next stepI just found and started reading your blog regularly – I love it! I actually found it because I realized I needed a swift kick in the tush to get my finances in order and did some searching online. My first step in the tush-kicking process was to pay off my credit card debt (it’s completely gone – yay!). With that being said, I have a quick question for you about what I should do next.

Is it better to …

1. Double up on my car payments and get that paid off? I have a 2007 Nissan Sentra that I bought used and that I owe about $8,000 on still. I could double up payments and still put away about 25% of my pay each month into savings.

2. Increase my car payment by half and then put the other half towards my student loans? I have about $13,500 left on those.

3. Take the extra money and not do 1 or 2 and put it all into savings instead? My savings account has just hit 10K.

Originally, my plan was to double up payments and tackle the car loan. Once that was complete, I was going to add the money I was spending there to my student loans to get those knocked out. Once the car payment and student loans were gone, everything would go to savings. In the meantime, I would concentrate on saving at least 25% of my monthly pay and putting it directly into my savings account. In addition, I have a second job (I work a shift or two a week in retail) where I make about $30-$50 a week. I’m viewing this money as pretty much “untouchable” and just adding it to my savings. - Carrie

I would focus on paying off whichever loan has a higher interest rate first. If they’re roughly equal, then I would focus on the car loan first, because that has collateral.

Splitting up the payments as you describe has little or no benefit – you’re far better off focusing on one of the debts. Splitting up payments delays the payoff date for both loans while also giving the higher interest loan more time to grow.

So, assuming your car loan is the high interest rate loan, I’d go for the first option.

Q4: More for the mortgage?We are in a good financial situation with 12 months emergency, funding retirement and college accounts and our mortgage as our only debt. We bought our condo 4 years ago and moved for work about 10 months after closing. We rent it out to great tenants and are happy with the situation for now. We plan on staying in our current city at least 2 more years but even if we do move don’t plan on moving back to our place. We would consider selling it especially if the current tenants want to move out. Our neighborhood has continued to appreciate. We put 50% down and have a 30 year fixed at 6.25%.

I looked into refinancing but since it’s treated as an investment property the rate wasn’t significantly better. It didn’t make financial sense given it’s 99% certain we’ll sell the place within 5 years.

I know it’s often advised to make extra payments on a mortgage once the rest of the financial picture is good. I feel like we’re there but given that it’s a rental and that if we sell we would probably pay capital gains tax I’m wondering if that’s good advice for us. I’m talking with our accountant next week about the capital gains question and if there’s any way we can avoid it since we moved for a job promotion.

Should I put more towards the mortgage? If not, where should I put the additional savings we have each month? - Wendy

Regardless of whether you pay off the mortgage early or not, you’re going to have the same capital gains tax issue. You paid $X for the house several years ago (financed with a mortgage) and hope to sell it for $Y in a few years. The taxable amount on the capital gains is still $Y-X, no matter whether the financing still exists or not.

So, the real question is whether or not it makes more sense to pay down a mortgage at 6.25% or to use it elsewhere. Paying down the mortgage has the benefit of providing a guaranteed 6.25% “return” on your payment (every dollar you pay on the mortgage eliminates interest in subsequent years). It also has the benefit of improving your monthly cash flow.

Since there is no investment out there that will return you a guaranteed 6.25%, I’d pay down the mortgage.

Q5: Saving up for paymentsI’m trying to payoff my car loan ASAP (@ 6 years 9.8% interest… ugh). I am currently contributing about an extra $150 a month to help pay it off sooner ($500 total); but at that rate it will take forever it feels like (Current Balance: $20,282.xx)

I also have a automatic transfer to my savings account which is $180 a week (180 x 4.3 = $774 a month). That balance is 30% of income. I am pretty comfortable with my current savings balance.. covers about 3 months with bills.

SO! My question is this…

Instead of contributing that extra $150 to the loan, what if I put it in my savings along with the “extra savings” ( I now plan on using the $774 a month as a car payment now that I am comfortable with my savings balance) and let it earn interest (very little yes) and build it up + the minimum payments I will be making now and pay it all off in one transaction after about 18 months? Is it wise to do this? One advantage I think is that I will be maximizing my savings but this assumes nothing goes wrong for the next 18 months…….. - Dan

That’s a really bad idea. Here’s why.

Let’s say you make a $200 payment on your loan right now. That payment will eliminate $19.60 in accrued interest this year, about $20 in accrued interest the year after that, and even more the year after that. Your $200 turns into about $260 (or so) if you have your loan paid off in three years, because you’ll be paying $60 less in interest over the lifetime of the loan if you make that $200 extra payment right now.

On the other hand, if you put that $200 in a 1% savings account, it’ll earn about $2 a year. Your $200 turns into only $206 in three years.

Although it feels painful, the best choice by far is to keep plugging away at that car loan as hard as you can.

Q6: Package price increaseI signed up for a Dish Network contract last year (don’t ask me why – this was before i started reading your blog) – the price was supposed to 39.99/month for 2 years. First year they would give me a credit of $15/month bringing down the price to 24.99/month.

Now they increased the price to 44.99/month. I called them and inquired about this – i was told that they can increase the price of the package though i’m in contract. Which i felt was odd – shouldn’t there be an option for me to get out of contract – if there is a price increase in the contract.

Is this legal even? - Ron

It depends on the contract you signed, but it’s most likely legal. Most contracts allow the company to adjust the price of such packages in almost any way they wish.

The reason that they don’t jack the price way up is that they’d have many more problems. Lots of customers would stop paying, and even those that could pay would be looking to jump ship at the end of the contract.

Still, if you’ve signed a contract with them, you’re going to be living with their price hikes, unfortunately.

Q7: Maximize investments or pay mortgage?I am a 53 year old single mom in southern California who returned to the work force five years ago. I am fortunate enough to own a home and to receive $79,000/year from my job, plus another $14,400/year from a divorce settlement pension. I have only about $4,000 in liquid savings.

I own my home, which is valued at about $255,000, about $200,000 less than it was 8 years ago. I owe $166,500 at 5.5% fixed on my first mortgage and $90,300 at 3.25% variable on my HELOC (from a time when I was too ill to work – I haven’t used it in 5 years). My total payments are $1,550 plus I put an extra $200 towards principle into the HELOC every month. (The HELOC minimum payment has been as high as $500 back when interest rates were at 8%). I have no other debt, but will need a car soon to replace my 1997 4-Runner and am putting $300/month into a savings account for a future car purchase. I have cut my expenses to the bone (insulated the house, no land line, cheapest cell plan, no cable TV, use the library, cook at home, carpool, thrift store shopping, etc. etc.).

Currently I contribute about $1,000/month into the pre-tax, government equivalent of a 401k plan, and have a balance of $41,000. I also have an annuity of about $70,000 with a guaranteed 7% return.

I plan to retire at age 66, when my (unfortunately taxable) total income sources will be about $1,700/mo from social security, $1,200/mo from the one pension, $2,900 from another pension, plus any investment income. At the current payment rate, my mortgage and second will be far from being paid off when I retire.

I figured out that if I throw another $500/month into the mortgage and HELOC principal, they would be paid off by the time I retire, which would be like having another $1,550/month in income. But then I’d only be contributing $500/month into my pre-tax investments so they’d be worth far less when I retire. Also with the mortgage paid off I would not have the interest write-off on my taxes.

So my question is, in this instance, would it be better to pay $1,000/month toward the pre-tax investment, or split it 50-50 with extra mortgage & HELOC payments and pay off the mortgage within 12 or 13 years? - Joyce

You should not plan on retiring at age 66 if this is your financial situation. Retirement at that age would mean some extremely lean living regardless of what path you choose right now. The numbers simply don’t add up to a healthy retirement in thirteen years, no matter what.

The first step I would take is talking to my lenders about refinancing both the fixed rate mortgage and the adjustable rate HELOC into a single fixed rate loan. Interest rates are going to rebound and when they do, you’ll be in an even worse position. Lock those two in as low as you possibly can. If you can’t refinance (which might happen, depending on your financial institution and your payment history), focus solely on paying things down until you can refinance. I would focus on whichever of the two has the higher interest rate at the moment and keep your eye on lowering that amount to whatever numbers are needed for you to refinance. Don’t worry about the tax writeoff of your mortgage interest – it is a small perk, nothing more, nothing less.

Once you’ve done that, I would just make the minimum mortgage payment and save every dime that I could for retirement. Once you’re in that situation, your monthly mortgage payment will be lower than your mortgage payment is right now, let alone your HELOC, so your monthly cash flow will be better.

The key then is to keep working and saving until you reach a point where you can safely finance your life with your pensions and retirement savings. I would be surprised if that happens by age 66, unfortunately.

Q8: Exercising at homeI know you may have addressed this before, but I am really interested in a frugal but smart way to exercise at home. So many at-home options seem cheesy and cheaply made. Going to the gym is not an option with my work schedule and kids. As well, I live in a tiny town and would have to drive 12 miles to the nearest YMCA.

Currently I am using resistance tubing ($5 Walmart, 2 bands, but they will need replacing in a few months) and one 12-pound set of dumbells. Do you have a post that talks about this? - Sheila

Deciding where to exercise is more about goals and about where you’re at in terms of shape than anything else.

If you’ve never exercised before, your best bet is to simply start a walking routine to get yourself up to a solid level of cardiovascular fitness. By walking, I don’t mean trudging for a little while, I mean walking at a reasonably fast pace to get your wind up a little. Since spring is dawning, now is the perfect time to start doing that outdoors.

If this is already easy for you and you’re looking for more intense training, I would probably point you towards a gym situation. The next step for most people is weight training, and focusing too much on a single muscle group is actually somewhat dangerous. The equipment needed to push lots of different muscle groups in turn would be expensive, and a gym membership is cheaper than the equipment, especially if you’re unsure if this is just a fad for you.

Again, if you’re not exercising now, start by walking. If that’s a routine you can’t establish on your own, then a gym membership would most likely be a waste of money.

Q9: Buy cheap or reliable?I’m in my 20s, snowballing my (currently) $80K in student loan debt, and I’m getting closer to moving out of my parents house. I’m going to be in debt for a long time and will need to buy house-things soon. There are the expensive-frugal options (a $250 vacuum that reliably lasts for 10 years) and the cheap-frugal options (a $50 vacuum that sometimes lasts 3 years, but has a big risk of “lemons”). Sometimes the most frugal choice, the expensive-frugal, is just too expensive. Sometimes it is be do-able, but at the expense of putting that money toward debt. How do I choose between expensive-fugal and cheap-frugal purchases? In the absence of a compelling reason to choose one over the other (expensive vacuum would substantially alleviate asthma or cheap vacuum is good enough because I only vacuum twice a year anyway), I find this to be an especially difficult decision. Even making these choices strictly mathematically is difficult because I can’t really know how long anything will last. - Jessica

My suggestion for people in your situation is to buy everything you need at first as cheaply as you can, utilizing Goodwill and the like. Do not go into debt furnishing your house for the first time.

Over time, start replacing things. The things you use frequently will be the things you break first, so those should be the ones that you replace with high-quality items. In other words, you’ll be able to tell what things you use a lot by what things break quickly because you’ve used them a lot.

With your vacuum analogy, I’m not sure if vacuuming only twice a year is a good choice if you have asthma. My understanding is that frequent vacuuming is a much better choice, as it keeps allergens from building up and makes people with asthma less dependent on rescue medications.

Q10: Inherited jewelryI inherited a fair amount of jewelry from my mother; it’s all 14 and 18k gold, and a lot of it has precious stones as well. None of it is anything I would ever wear – too big and gaudy – so I am wondering if I should sell it while gold is high and bank the proceeds, or hold onto it as a hedge against some future dollar devaluation. (Sometimes my common sense goes on vacation and I fall prey to the apocalyptic predictions swirling around and envisage myself someday having to barter a ring for food or something.) Any advice? What would YOU do? - Lisa

The first thing I would do is get it appraised by a jeweler that I trusted, probably by more than one. Make sure you have what you think you have, and ask them for what they would do if they were looking to sell it.

Often, jewelers buy such items directly, and you’ll get more out of jewelry that way than by selling them for scrap gold. Even if they’re not interested in buying it, they’ll have good suggestions for what you should do with it locally.

A close friend of mine inherited what he believed to be a ruby ring, but when he had it appraised, the ruby turned out to be fake. This is actually something of a regular problem with inherited jewelry, at least in my understanding of it.

Got any questions? Email them to me or leave them in the comments and I’ll attempt to answer them in a future mailbag (which, by way of full disclosure, may also get re-posted on other websites that pick up my blog). However, I do receive hundreds of questions per week, so I may not necessarily be able to answer yours.

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